Unemployment, Slow Growth Delay Fed Rate Hikes

High unemployment, tame inflation and moderate economic growth will likely mean the U.S. Federal Reserve will hold off until next year to raise official interest rates to 0.5 percent, a Reuters poll showed.

Fears that contagion from euro zone debt problems might again push the world into a crisis akin to that seen in 2008 also came into play in the forecasts of the U.S. central bank.

The survey of more than 90 economists, taken in the past week, suggests the U.S. central bank will maintain interest rates at the current ultra-low level near zero for some time and then hike to 0.5 percent in the first three months of 2011.

A similar survey in May suggested economists were looking for a Fed rate increase to 0.5 percent in the fourth quarter of this year.

"When unemployment is unusually high, a central bank has good reason to leave rates as low as possible as long as possible to optimize growth before inflation starts to rise," said Chris Low, chief economist at FTN Financial.

Inflation is not expected to rise anytime soon, according to the survey.

The core consumer price index, which does not include food or energy prices, should rise by 0.9 percent in the second and third quarters of this year and then ease to 0.8 percent in the fourth quarter, according to the median of forecasts from the poll.

Expectations for core CPI this year vary widely from 0.8 percent to 1.7 percent, with the median at 1 percent. Core CPI for 2011 is forecast at 1.4 percent.

Headline inflation will likely ease from 2 percent in the second quarter of this year to 1.2 percent in the fourth quarter, with expectations pegged at 1.8 percent for all of 2010 and the same in 2011.

U.S. growth is forecast to slow down late this year, adding to pressure on the Fed to leave rates untouched.

According to the median of forecasts from the Reuters poll, gross domestic product will dip from an annualized 3.5 percent in the second quarter of 2010 to 2.8 percent in the fourth quarter, then to 2.7 percent in the first half of next year.

Growth for next year is expected to moderate to 2.9 percent from 3.2 percent in 2010.

"The lower the expectations on GDP, the longer the Fed has to keep rates low," said Kurt Karl, chief U.S. economist at Swiss Re, adding "right now the expectations on growth are in a pessimism phase."

The U.S. government said late last month the economy grew at a 3 percent annual rate in the first quarter of 2010. The third and final estimate of first quarter U.S. growth will be released late next week.

Economists see only a fifteen percent chance of a double dip recession in the U.S. in the next twelve months, with forecasts ranging from zero to 49 percent.

Economists also cited the possibility the euro zone debt crisis could grow into another global credit crunch as another reason the Fed would remain on the sidelines when it comes to rates.

"As yet, our growth forecast has been pared down only slightly due to mild contagion from the European debt crisis — any further downward revision will hinge upon the length and depth of the concerns over sovereign debt," said Ellen Zentner, senior economist at Bank of Tokyo-Mitsubishi.

Stubbornly high unemployment also suggests the U.S. Fed will be in no rush to raise benchmark interest rates, and the vast majority of poll respondents said they believed that unemployment rate in the U.S. economy had already peaked.

The U.S. unemployment rate in May was 9.7 percent, according to government data, down narrowly from a recent peak of 10.1 percent in October 2009.